Long title, short story.
You want to win a Noble Prize in Economics? Figure out why, when bad news comes out about the economy, the market goes up and when good news about the economy comes out, the market goes down. Yes, I do know that the Fed, presently, is watching signs about the economy and they will make their next decision based on those signs. The data tells them a story and that is the story they use when making rate hike (or lowering) decisions. I get that.
I also get that market moves are generally predicated on the scarcity or abundance of money in the system. For those of a certain age, we used to wait on the M-1 money supply numbers and then watch the markets move. So this is an age old phenomena and it makes sense, tightening, or making money more expensive slows growth and earnings will be impacted, and vice versa.
Yet, when data points suggest something negative, markets rally. Why, because it has the opposite effect on Fed policy, thats why. Yet, investors seem to forget that a negative data point points out something that is not meeting expectations and that is not a good thing.
There should be a name for this scenario. “Good News is Bad News” is too simple and to the point. I will have to think about that for a bit.
Anyway, these market rallies that coincide with bad or negative news have always bewildered me. If, for example, we get a bad JOBS report next week. Unemployment is up, wages have stagnated, etc. Markets will fly. Huh? Why? More people are unemployed. Inflation is eating away at family budgets and wages are flatlining. How can this be good for the economy? It’s not. While market readings have always mystified, this bad news is good news scenario confounds me. Again, I get the Fed will react a certain way but is the Fed all that powerful in actuality?
It is pretty clear how I have felt about the Fed’s “late to the party” attempt at slowing inflation. I am with everyone else. I may have been a little early in calling them out for believing that inflation was “Transitory” but we all can agree, they blew it early and often.
I am no economic savant. I like it simple and clear and I like things that make sense and The Bad News is Good News concept doesn’t. It never has.
Seeing markets react to bad news that actually directly impacts consumers and the manufacturing sector is what gets me.
For example, If consumer sentiment drops significantly, why would markets rally? Consumers are roughly 70% of the economy and if they decide to pull back, that means that retailers will suffer, service sector will suffer, consumer durables will suffer and the list goes on. The impact on those sectors could be: Layoffs, stagnant wage growth, shifting manufacturing to foreign locations and earnings contraction. All of which are not good for the economy or the stock market. Right?
This is where the mystical power of the Fed comes in. These negative reports send a signal that the Fed might take a less aggressive stance and markets love a less aggressive Fed. Yet, on the ground, the economy is not doing well and people are going to suffer with this lack of growth, yet the markets think this is a good thing.
Bad new is bad news. Investors tend to read into things in contrarian way and they think that it works. That’s where these rallies have come from. The belief in contrarian thinking. Yet, at the end of the day, it is about earnings and a slowing economy slows earnings and that is what we will be seeing for the next six to nine months. The market folded to a bear market level for a reason. That reason has not changed significantly but investor sentiment has. It is because of the “Bad News is Good News” phenomena.
While all of this confusing, the overall point I was trying to make is this: What has more power? The Fed raising or lowering rates or important trends in economic data? I am in the economic data camp because I believe that current flows of information regarding the health of an economy is more relevant at that particular time, than any Fed move. These pieces of current information are a better indication of corporate health rather than worrying about a Fed rate hike. That should be the foundation of making an investment or not, the health of the company or a sector should be the basis for investment.
Excellent article, its the earnings, earnings, earnings. It is the health. The fed is consistently "late to the party" then comes the over reaction.